Investment market updates

Inflation rates peak and start to fall

Interest rates have started to fall around the world, with the Bank of England making their first cut in August since March 2020, reducing the base rate from 5.25% to 5%. The US Federal Reserve cut rates by a larger than expected 0.5% in September, to a new range of 4.75% to 5%.

Interest rates rose sharply through 2022 and 2023 to tackle soaring inflation, but higher rates also stifle investment and economic growth, so there is a balancing act. With inflation now close to most central bank’s targets of 2%, they have started to lower rates to more ‘normal’ levels.

The Centre for Economics and Business Research has forecast that interest rates will fall to 3.75% in the UK by the end of next year, with markets predicting rates will settle between 3% and 3.5% in 2026.

Escalating conflict in the Middle East

One of the biggest reasons inflation has fallen back to target levels is that the price of oil has gone down, as well as prices for other key commodities like copper. The price of brent blend oil eased to $75 by the end of September, after peaking at $140 per barrel in March 2022. It hasn’t been a smooth journey downwards, but supply has been more than enough to meet weakening demand, notably from China, where economic growth has been slowing.

Risks are rising though, and brent oil has pushed beyond $80 as the situation in the Middle East worsens. There’s been speculation around whether Israel would directly target Iran’s oil facilities. OPEC has enough spare capacity to offset any disruption, but this could lead to a rise in global energy prices which may slow or stall interest rate cuts.

Strong gains from shares

Interest rates have peaked and are now starting to fall which has helped drive share and bond markets higher. Lower borrowing costs are good for both businesses and consumers.

For the 12 months to end Sept 2024, global share markets rose 20% (in GBP) when factoring in the reinvestment of dividends. The world’s largest stock market, the US, was up 24% (S&P 500 measured in GBP) as strong consumer spending contributed to US Gross Domestic Product (GDP) growth, which rose to an annualised rate of 2.8% in the second quarter of 2024.

In previous updates, we talked about the magnificent seven US tech firms (Microsoft, Meta, Amazon etc.) driving US share market upwards. These seven companies now represent nearly one third of the S&P 500 index, showing how concentrated the US market has become.

Warren Buffet’s Berkshire Hathaway investment company took 59 years to reach market capitalisation of $1 trillion. Nvidia added $1trillion in just 23 trading days earlier this year (source: Deutsche Bank), showing the unprecedented rise in stock valuations of some companies over the last year.

There are signs that this surge in the valuation of US tech firms linked to Artificial Intelligence (AI) has started to slow down. Whether these high valuations can be maintained by these companies over time will largely depend on whether AI can generate meaningful cost savings for companies or create new revenue streams.

In the UK, the FTSE 100 reached a new record high of 8,445 mid-May before falling back a little to 8,237 by the end of Sept. For the 12-month period, and assuming dividends reinvested, UK stocks (represented by the wider FTSE All Share Index) returned 13.4%. European stocks performed a little better than the UK (14.5%).

Chinese stocks, a key component of our emerging market equity allocation, had a very strong September after a disappointing start to the year, returning 21% when measured in GBP. Chinese stocks surged on speculation of a stimulus package, including lower interest rates and some property reforms, while the government also reiterated its commitment to the 5% annual GDP target.

Bond markets

Bond markets have also been performing well over the last year. The broadest measure of global bonds was up 10% (including reinvestment of interest) for the 12 month period. UK Government Bonds (across all maturities) returned a little less at 8%.

Bond values go up and down based on how markets think interest rates will change over the term of the bonds. Changes in interest rates make the future income payments from bonds, which are usually fixed at outset, more or less valuable in today’s money.

Bond values have recovered from most of the falls caused by the sharp hike in interest rates in 2021 and 2022. Part of the recovery is the expectation that interest rates will fall from current levels over the next 12 - 24 months. The three-year return for the same global bond measure now stands at -1% total return, clearly not a great result, but with bond yields (income divided by price) relatively high at the moment, even without further capital appreciation, returns should be positive going forward.

Virgin Money investment funds

Returns were more muted during the third quarter of 2024, with most of the gains from share and bond markets being realised earlier in the year. However, when looking at the 12 months to end September, all Virgin Money investment funds enjoyed strong returns ranging from 9% on the Defensive Fund to 18% for the Global Share Fund.

Our Cautious, Balanced and Adventurous growth approaches grew 12%, 15% and 17% respectively, during a period when taking on risk was rewarded, with shares outperforming bonds and riskier bonds (such as high yield) outperforming safer bonds (such as government bonds).

Most of our investment funds benefit from a global investment approach, with only the UK Index Tracker Fund (up 13% for the period) investing only in the UK. The strong returns from US shares helped boost returns for the three growth approaches and the Global Share Fund in particular.

The Global Share Fund (+18%) was slightly ahead of the Climate Change Fund (+15%). Both funds invest globally, but the Climate Change Fund focuses on a much smaller number of companies (35-45) who are developing products and services to tackle climate change and other environmental factors. Global Share Fund, via its fund-of-fund structure, uses some passively managed strategies and has exposure to over 1000 more companies.

The Bond Fund had a strong 12 months, returning close to 11% with income reinvested. The fund invests just short of 30% in BBB rated bonds, and these added value over AAA-A rated bonds, returning 12% compared to 8%. Corporate bonds are given ‘credit ratings’ by leading credit agencies to indicate how risky lending money to that company (via the bond) is. Lower rated (BBB and BB) bonds yield more as they are riskier, but can be a good source of additional return when economies or companies are performing well and default rates are low, as they have been over the last few years.

You can see the return for each of our funds over the last five years on each fund’s web page.